Tax reform takes a good turn

By John Hood | Jun 19, 2013

RALEIGH — Life, the old saying goes, is best thought of as a journey, not a destination. When it comes to reforming North Carolina’s tax code, however, I’d say the reverse is true. The journey may have been messy over the past few months, as state lawmakers and policy analysts pitched and debated various plans. But in the end, all that will really matter is the destination.

Now that both the North Carolina House and Senate have fashioned tax-reform plans and are working out a consensus bill, I have some good news for you: the destination looks great.

The House tax bill is a good first step towards a simpler, fairer, pro-growth tax code. It cuts marginal tax rates on work, savings, and capital formation, and provides net tax relief to most North Carolina households. As a net tax cut, it has a fiscal impact equal to about 1 percent of the state’s General Fund revenue in the short run and about 2 percent in the long run.

The Senate’s new tax bill is an even bigger step towards a kind of tax code North Carolina needs. It establishes a 5.25 percent flat tax on personal income and eventually eliminates the corporate income tax, which is responsible for a disproportionate share of the complexity and economic damage imposed by the state’s entire tax code. If the Senate tax bill became law, North Carolina would go from having one of the nation’s worst tax climates for business to having one of the nation’s best.

Moreover, the new Senate bill was carefully designed to address concerns about the original Senate bill, which sought to expand the sales-tax base to more than 130 services and goods not currently taxed at the state level, including food. Those provisions served to impose new regulatory burdens on service industries and raised taxes on some North Carolinians of low to moderate incomes.

Forget all that – it’s gone. According to the legislature’s Fiscal Research Division, the new Senate tax bill will reduce taxes for virtually all North Carolina households — poor, wealthy, and in-between.

The flipside of doing that, however, is that the new Senate bill results in a larger net tax cut than either the House bill or the original Senate plan. It works out to about 2 percent of General Fund revenue in the short run and 5 percent in the long run.

It’s important to remember that the primary reason to reform the state tax code is to rejuvenate North Carolina’s economy. It needs it. Despite a modest uptick in job creation in recent months, our state continues to suffer from one of the country’s highest jobless rates and one of the country’s lowest growth rates in per-capita income.

Since the early 1990s, many of North Carolina’s national and international competitors have adopted pro-growth, market-oriented policies, including lower marginal tax rates on work, savings, and investment. Unfortunately, our leaders at the time chose to do nothing or even to go in the opposite direction. Since the mid-1990s, our economy has underperformed the regional and national averages. Even in boom years, we didn’t match the pacesetters. During the Great Recession, North Carolina swooned.

Tax reform is just one element of a broad comeback strategy for the state’s economy. We also need regulatory reform in the short run and better roads and schools in the long run. But tax reform is indispensable. Over the next few years, it’s worth devoting a significant share of the state’s annual revenue growth to making our tax climate more competitive. More capital formation and job creation will, in turn, generate more revenue to improve public services. North Carolina must trade in our current vicious cycle — weak economic performance producing chronic budget woes — for a virtuous cycle of growth and investment.

The House tax plan puts us on the road to the right destination. The new Senate tax plan puts us even further down that road. Let’s make the journey as short as possible.

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Hood is president of the John Locke Foundation, which has just published First In Freedom: Transforming Ideas into Consequences for North Carolina. It is available at JohnLockeStore.com.